Unlike franking credits, which aren’t disclosed on a company’s balance sheet but can be found in the footnotes to its financial statements, tax losses may or may not be disclosed on a company’s balance sheet.

It all depends on whether the accountants believe it is probable that future taxable profit will be available to utilise these tax losses.

If so, then the ‘tax-effected’ amount of the tax losses will be included in Deferred Tax Assets on the company’s balance sheet.

What do I mean by ‘tax-effected’? Essentially this is the cash taxes the company will save by utilising the tax loss to reduce its taxable income.

To use an example, if a company makes a $100m taxable loss, all things equal it will record a deferred tax asset of $30m (ie the 30% corporate tax rate multiplied by $100m).

Austin Engineering (ASX:ANG), held in our InvestSMART Small Companies Fund, has around $10m in tax loss deferred tax assets at 30 June 2017. This supplier of trays and buckets for dump trucks and front-end loaders, respectively, used by miners suffered greatly during the mining downturn as miners substantially reduced their capital expenditure.

However, with rising commodity prices finally encouraging miners to loosen their purse strings and after having restructured and reduced debt, Austin is likely to earn taxable profits once again in coming years. As such, these $10m in deferred tax assets will reduce its cash tax bill.

Hidden losses

This can occur when a company that has previously been making tax losses that the accountants haven't allowed to be recognised on its balance sheet subsequently moves into a taxable position, perhaps due to a restructure or just improving industry conditions.

In such situations, accountants’ inherent conservatism means the company in question will usually need a few years of improved operations before it’s permitted to recognise any remaining tax losses on its balance sheet.

US-based car company General Motors (NYSE:GM) provides a good example. After going bankrupt in 2009 and being restructured with the help of a sizable investment by the US government, General Motors exited bankruptcy a much leaner, more efficient car manufacturer, particularly in its US and Canadian operations, with substantially reduced debt and pension obligations.

Investors that just looked at its balance sheet after it relisted on the New York Stock Exchange in November 2010 wouldn't have noticed its US$14.9bn in accumulated US tax losses and credits. These tax losses weren't recognised in Deferred Tax Assets in 2010 because the company wasn't then deemed by its accountants to be 'more likely than not' to generate profits to utilise these losses, despite the likelihood of this having increased after its bankruptcy and restructuring.

However, after three years of profitability in its US and Canadian operations and forecasts of same, the accountants permitted much of these tax losses to finally be recognised on its balance sheet in 2012.

Valuable

In theory, the value of any company is the discounted value of its future net cash flows, from which of course you have to deduct tax payments. So, to the extent a company doesn’t have to pay tax, it is worth more than an identical company that does.

However, for Australian and New Zealand companies at least, if a company is using accumulated tax losses to reduce its cash tax payments, then this means it's also not accumulating franking credits.

Even so, like franking credits, the potential value of tax losses illustrates that reading the footnotes to a company’s financial statements are just as important as looking at the financial statements themselves.

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